In most major economies growth seemed slow enough in June to hold out hope of a patchy moderation in inflation and allowed some central banks including the Bank of Canada and European Central Bank to start cutting interest rates. The US Federal Reserve and the Bank of England decided to wait longer at their June meetings before cutting while the RBA is an odd-man-out, facing stickier inflation than elsewhere and considering another rate hike at its meeting in June before deciding to stay on hold. What promised to be another strong month for risk assets in June driven by hope of official interest rate cuts was marred for some in Europe by rising concern about the strong electoral performance of far-right political parties threatening to turn back further the clock on the globilisation of goods and labour markets.
Government bond yields had a mixed month. US bond yields moved lower in June reflecting the possibility of a modest Fed rate cutting cycle ahead. Australian bond yields, in contrast, rose a little as the market started to build in the possibility of a rate hike in August. An unexpected rise in annual inflation in May saw a bigger lift in Australian bond yields before moderating towards the month-end.
Major share markets had a mixed performance in June. Some experienced gains including the US S&P 500 and Japan’s Nikkei, both up 2.9% in June, as well as Australia’s ASX 200, up 0.9%. However, European share markets lost ground in June under a cloud of rising political risk with a strong showing by nationalist/far right parties in the European Parliament election. The imminent elections in France and Britain also weighed on sentiment. Chinese share markets were also weaker in June reflecting China’s soft economic growth prospects weighed down by the continuing weakness of property development companies. Hong Kong’s Hang Seng fell 2.0% in June while China’s CSI fell 3.3%.
Briefly looking at the year ending June 2024, America’s comparatively firm economic growth and leadership in artificial intelligence companies saw the S&P 500 up 24.8% and the tech-heavy NASDAQ up 28.6%. Japan’s Nikkei also showed a handsome gain of 19.3% and even after recent setbacks Europe’s major markets showed good gains with Germany’s DAX up 12.9% and Britain’s FTSE 100 up 8.9%. Australia’s ASX 200 was up 7.8%. China’s persistent property sector issues casting a shadow over its economic performance resulted in a mostly soft share market over the year with the CSI down by 9.9% and Hong Kong’s Hang Seng down by 6.3%.
Returning to the June month, mixed share market performance was reflected in credit markets. In Australia, households and businesses are under pressure from comparatively high interest rates but continue to cope better than might have been expected given predominantly floating interest rates on borrowings and a high household debt burden by international comparison. High and rising house prices mean that the still small cohort of households defaulting on home loans are not making losses on home sales. Another cash rate hike, if it occurs, may mean more households defaulting but limited by rising wages, tax cuts and higher government support payments boosting household disposable income.
The lift in household disposable income this year (a greater lift than is likely in most other countries) represents a two-edged sword both potentially boosting demand in the economy but also potentially sustaining inflation pressure. Already, Australian inflation is showing signs of tracking higher and being stickier than elsewhere internationally. The May CPI report shows annual inflation lifting to 4.0% with underlying (trimmed mean) inflation rising to 4.4% goes materially against the grain of inflation tracking high 2 to low 3% range in the US and mid to high 2% in Europe.
Government bond market performance in June reflects Australia’s poorer inflation performance. In the US 2 and 10-year bond yields fell respectively by 22 basis points (bps) and 15bps to 4.75% and 4.40%. In Australia, 2- and 10-year bond yields rose respectively by 14bps and 5bps to 4.16% and 4.31%. US bond yields even after their better relative performance in June still sit higher than Australian bond yields but not by much after considering that the US Fed’s Funds rate is 5.50% much higher than Australia’s 4.35% cash rate and the US budget position (and government funding problem) at more than -6% of GDP, is much worse than in Australia running around -1% this year.
Australia’s relatively poorer bond market performance looks set to persist as the RBA wrangles with an inflation outlook making it less likely it can get inflation below 3% by the end of next year. In the near-term, there are key factors that are still supporting inflation nearer to 4% than 3% including wage growth running around 4% y-o-y with still no appreciable improvement in productivity and tax cuts and additional government payments supporting demand growth in the economy in excess of limited growth in supply (a problem that is acute still in housing a big component of the CPI).
We still believe that the hurdle is set high for the RBA to hike rates further. It will want to get a clearer view of inflation from the more comprehensive Q2 CPI report out later this month. It will also want some information about how demand is responding to the various income support measures taking effect from July1st. It is possible that much of the rise in household disposable income will feed saving rather than spending and that may be enough to keep the RBA on rate hold. The relative tightness of the labour market over the next two or three months will also matter as the RBA considers whether to hike or not.
We doubt whether the RBA will have sufficient information to warrant hiking rates by early August and a more realistic date for a hike, if it occurs, is the early November policy meeting. What is more certain is that the RBA will not have to hand economic reports that warrant cutting the cash rate for many months to come. Our thinking for a first rate cut taking the cash rate below 4.35% has been mid-2025, but we are pushing that out to late-2025 at earliest. That implies that Australian bond yields will trade mostly 4% yield and higher through much of the next year.